Beyond procurement: Transforming

indirect spending in retail

If retailers treat indirect costs as an opportunity for business transformation rather than just a
procurement matter, they can boost return on sales by as much as 2 percent.

Steve Hoffman and Patrik Silén

AUGUST 2018 • RETAIL © Natee Meepian/Getty Images

 For retailers seeking to cut costs and generate cash for
growth investments, indirect spending can be a big
untapped opportunity. Indirect costs—the goods and
services that retailers purchase but don’t resell—are
equivalent to 10 to 15 percent of sales on average, and
most retailers know that their indirect spending is far
from optimized. But while recognizing the potential
is easy, capturing it has proven stubbornly difficult.
The challenges aren’t new. They include a lack
of spending visibility, fragmented ownership
and spend authority, a dearth of incentives to
reduce indirect spend, and a siloed approach to
procurement of not-for-resale (NFR) categories. In
addition, indirect procurement typically focuses
on negotiations with suppliers over price, rather
than on higher-impact opportunities to optimize
what and how the retailer buys. Our research has
also shown that capabilities and resourcing for NFR
procurement in retail are significantly weaker than
in many other sectors: NFR goods and services
are viewed as much less important than goods for
resale, so the NFR sourcing staff tends to receive
less management attention and less investment
in talent. Furthermore, even NFR sourcing
professionals typically have little expertise in NFR
categories. Rare is the procurement team that has
deep knowledge of, say, elevator maintenance or
marketing-agency overhead costs.
Visionary retailers, however, are taking a radical
new approach to indirect spending—and achieving
radical results. These retailers aren’t viewing
indirect costs as a concern only for the procurement
function. Instead, they’re looking to transform
indirect spending across the entire business. They’re
overcoming the challenges by leveraging three new
ways of working: a cross-functional approach that
incorporates category-specific demand levers, the
use of digital and analytical tools, and stronger
supplier collaboration. And they’re taking specific
actions to bring about lasting change in mind-sets
and behaviors.
2 Beyond procurement: Transforming indirect spending in retail
In doing so, retailers are shaving as much as 10 to 15
percent off their annual indirect spend, capturing
impact worth 1 to 2 percent in return on sales, and
seeing a more than fifteen-fold return on the cost of
their NFR sourcing team. We’ve found that the value
at stake is remarkably consistent across retailers—
even at those that have been working on reducing
indirect costs for a long time, whether in-house or
with external support.
A business transformation
To capture maximum value from a cost-reduction
program, retailers must be deliberate about the
program’s scope and ambition level. A broad scope
and high targets are indispensable elements of a
truly transformative effort.
Historically, retailers have cut costs primarily by
reducing store labor or travel expenses. Few retailers
have tapped into the full potential of optimizing NFR
spending (Exhibit 1). Furthermore, even retailers
explicitly seeking to reduce indirect spending
sometimes ring-fence certain cost categories as “not
addressable.” For instance, some retailers consider
marketing expenditures out of scope; their rationale
is that marketing is critical to the core business
of retail. Other retailers don’t bother trying to
lower rents, because they assume that they can’t
renegotiate terms unless they’re in financial distress.
Some indirect costs—such as supplier-managed
logistics—remain unchallenged because they’re
“hidden” in cost of goods sold. And some retailers
look for cost-reduction opportunities only in
operating expenses, leaving all capital expenditures
untouched—even though the latter often has higher
savings potential (as a percentage of costs).
In bypassing these categories, retailers are forfeiting
more than half of the potential impact and missing
out on the synergies that a large-scale program could
bring. To achieve transformative change in indirect
spending, there can be no sacred cows.
 Universal 2018
Beyond procurement: Transforming indirect spending in retail
Exhibit 1 of 3

Exhibit 1 By addressing the full cost base, a retailer can double the scope and savings of its
indirect-costs program.

Typical breakdown for a €10 bn retailer, € million

100 300 2,000

Capital
200 Supplier- expenditure
300 Private- managed
label costs
200 Rent packaging
900 Marketing

Typical Total
indirects scope scope

Typical savings, % 10–15 8–17 0–5 12–24 10–15 10–20 10–15

Source: McKinsey analysis

Another must-do for a transformation program: set
stretch targets that inspire creativity and out-of-
the-box thinking. To set its NFR targets, one retailer
first conducted a fact-based diagnostic that was
championed by senior leaders. This exercise helped
the organization understand that the program was
a priority, adopt a transformational rather than an
incremental mind-set, and focus on how to achieve
the targets rather than on trying to change them.
New ways of working
Seeing an NFR effort as a business transformation is a
crucial first step. To maximize NFR savings, retailers
then need to adopt three new ways of working.
A cross-functional approach incorporating
category-specific demand levers
Transformation of indirect spend will require the
involvement and commitment of more than just the
procurement staff. A cross-functional team can break
down silos, pose tough questions about what the
business really needs, and make balanced trade-offs.
A cross-functional team can pull the basic supplier-
management levers (such as competitive bids and
supplier consolidation) that affect who the retailer
buys from and at what price. The team can also
pull process-management levers, which influence
how a retailer buys: if the various functions comply
with procurement policies and use only preferred
vendors, maverick spending will be reduced or even
eliminated. Savings across the organization can be
more easily tracked. The retailer can better negotiate
vendor payment terms and cycles to its benefit.
Most importantly, a cross-functional team will be
better placed to pull category-specific demand-
management levers, which influence what the retailer

Beyond procurement: Transforming indirect spending in retail 3

 buys. In our experience, these levers deliver as much
as half of the potential savings—or even more for
mature companies, because negotiating for lower
prices yields diminishing returns over time. The
biggest opportunities are often in areas that many
retailers consider out of scope, such as marketing (by
using a return-on-investment approach, for instance)
or logistics (using levers such as inventory reduction
or network redesign).
A retailer, seeking to optimize logistics spending,
tasked a cross-functional team with redesigning
its distribution network. The team was able to
reduce end-to-end costs by selectively increasing
certain logistics costs. For example, it switched
some deliveries from sea to air in order to gain sales
and reduce markdowns. It also increased delivery
frequency for some products and stores while
decreasing it for others.
The use of digital and analytical tools
Digitization has revolutionized every business
process and will continue to do so; indirect sourcing
is no exception.1 Today, leading retailers are using
digital and analytical tools in the following areas to
achieve dramatic reductions in indirect costs:
ƒƒ Spend visibility. Advanced digital solutions,
powered by artificial intelligence (AI) and
machine learning, enable retailers to rapidly
and accurately map the relevant spend base into
granular categories, shedding light on exactly who
spends how much on what. Cutting-edge digital
procurement solutions can pull purchase-order
(PO) and invoice data from multiple systems to
create a “spend cube,” automatically generating
benchmarks on pricing and specs, as well as
dashboards and reports to help category managers
monitor spending. One retailer had recently
streamlined its headquarters organization but
found through AI-supported spend mapping that
many of the costs had crept back in through the
use of contractors and temporary labor. Once the
4 Beyond procurement: Transforming indirect spending in retail
retailer generated the spend cube using an agreed
taxonomy, it could lock down a baseline and see
how much it was spending on contracted versus
uncontracted vendors.
ƒƒ Consumer insights. A retailer used digital
consumer surveys and crowdsourced competitor
benchmarks to understand, address, and retest
consumer perceptions of store cleanliness.
Which areas of the store did consumers notice
most? Which areas did they hardly notice at
all? Analysis showed that the parking lot and
the sidewalks were perceived as clean enough,
so instead of hiring a cleaner to do a thorough
cleaning multiple times a day, the retailer cut
back to once a day, with store associates doing
spot checks every few hours. The surveys also
revealed places—such as fitting rooms and the
shoe department—where the retailer could invest
in more frequent cleaning to boost customer
satisfaction. The business-insights team then
measured the exact impact of these adjustments
on the retailer’s sales.
ƒƒ Design to value. A retailer reduced the cost
of its paper shopping bags by 25 percent by
redesigning them. Through digital analysis of
basket size, product dimensions, and data from
cashier surveys, the retailer determined the
ideal dimensions of a shopping bag based on the
distribution of physical volume and weight of
products. Further digital analysis—along with
input from cashiers, baggers, and vendors—helped
the retailer arrive at the substrate composition
that would give the shopping bags the right levels
of puncture strength and tensile strength.
ƒƒ Clean sheeting. Digital clean-sheeting tools
can reduce indirect costs by as much as 40
percent in a category. Such tools typically feature
algorithms for determining costs in various NFR
areas, dynamic databases of input costs (such as
raw-material index prices), and a sophisticated
 calculation engine. Through a clean-sheeting and take swift action to close gaps. ZBB,
exercise, one retailer discovered that it was which first gained traction in consumer-goods
paying much more than the “should cost” for companies, can be powerful for retailers,
water-bottle labels (Exhibit 2). especially in store-related NFR categories.
Determining the appropriate budget for each
ƒƒ Spend control. Digital procure-to-pay tools store, and then tracking adherence to that
give retailers better spend control by enforcing budget, can yield significant savings.
more discipline in how suppliers are set up and
approved, and by supporting a more rigorous Closer collaboration with suppliers
PO-approval process. Retailers should work with suppliers on cost
improvements and innovations. Suppliers can be
Zero-based budgeting (ZBB). Using digital
Universalƒƒ2018 great idea generators because they know a retailer’s
tools (and enabled
Beyond procurement: by increased
Transforming spend visibility),
indirect spending inbad habits better than the retailer itself does and
retail
Exhibit 2 of retailers
3 can easily build detailed bottom-up would rather help change those habits than lose the
budgets, detect the exact drivers of variances, business. Retailers can also invest in improving

Exhibit 2

Through clean sheeting, a retailer saw that it was paying more than the 'should cost'
for labels on its water bottles.

of measure1
Key assumptions

l Profit of 5% included in price l Interest rate of 3%

l Batch size of 2 million pieces (est.) l Selling, general, and administrative (SG&A) costs of 5%
l Yearly volume of 6 million pieces (est.) l Range of labor rates in local currency depending on skill level
ext
l Manufacturing location: Eastern Europe l Selling tax and value-added tax not included

Label costs for 500ml bottle

15%
Materials Value add Overhead and profit

Outbound
SG&A, Profit logistics
Overhead, R&D
Batch other
setup, manufacturing
Machinery scrap,
Inbound Labor costs
tooling
logistics

Raw and Landed Direct Total Target price Target price, Quoted
purchased material manufacturing manufacturing including
material cost costs outbound logistics

Source: McKinsey analysis

Beyond procurement: Transforming indirect spending in retail 5

 supplier capabilities in ways that will pay the
investment back several times over. Among the
benefits of stronger supplier relationships: better
product quality and availability, faster responses
to market needs, less administrative effort, greater
efficiency, and lower total cost.
The elements of successful supplier collaboration
include focusing on a limited number of suppliers
to deliver the highest return on investment,
establishing a robust value-sharing agreement at the
outset, creating a dedicated supplier-collaboration
team separate from but aligned with category
managers, and building a disciplined performance-
management and benefits-tracking system.
One retailer, when retendering its contracts for
outsourced warehousing, required suppliers to
submit proposals for improving the joint warehousing
operation. Based partly on these proposals, the
retailer reduced its supplier count to two, allowing
for closer collaboration while maintaining some
competitive tension. The retailer built continuous-
improvement targets into the contracts, with
gainsharing incentives for the suppliers. It also
invested in a “lean warehousing” team that works
closely with the suppliers to build capabilities.
Getting it done
Retailers must embed these new ways of working
into daily tasks. To sustain behavioral change,
they must then use all four parts of the “influence
model”2 (Exhibit 3).
Fostering understanding and conviction
Leading retailers lay out a clear case for change
and help each stakeholder connect to it on a personal
level. An important aspect of the change story is
communicating why savings are needed and what
they will be used for. Allowing business units or
functions to reinvest part of the savings can increase
motivation. (One initiative leader at a retailer put it
6 Beyond procurement: Transforming indirect spending in retail
this way: “Half goes to the CFO, but the other half we
get to keep.”) The head office should, of course, have
enough visibility into the reinvestments to ensure
they align with corporate priorities and generate
strong returns.
Intelligent target setting also helps foster
understanding across the organization. Targets
should be based on detailed diagnostics, including
benchmarking against a relevant peer set. Otherwise,
stakeholders will reject the targets as arbitrary;
there’s also a risk of damaging the business by
pushing it into “slash and burn” cost cutting. The
diagnostics should yield not just a single target—
say, $100 million in cost savings—but also a set of
quantified initiatives. Targets should include cost
ratios (for example, logistics spending as a percent of
sales) rather than just absolute numbers, to ensure
that cost efficiency genuinely improves even when
the category experiences tailwinds. (For example, a
decline in logistics costs due to a decline in sales isn’t
really an improvement.)
Because indirect sourcing is typically perceived as
a backwater and procurement staff can feel they’re
performing thankless work, external visibility can
be highly motivating. When retail CEOs publicize
their NFR initiatives and targets, the people involved
in the initiatives see that their work matters and even
has the power to influence their company’s stock price.
Along the NFR journey, there will be times when
stakeholders resist change for fear of negatively
affecting sales. A test-and-learn culture can
overcome this. A first step can be to show mock-
ups or samples of proposed changes. One retailer’s
procurement team recommended using thinner,
cheaper paper for marketing materials. It overcame
resistance from the marketing department by
having samples printed on the thinner paper and
using blind testing to demonstrate that the materials
were just as effective.
 Universal 2018
Beyond procurement: Transforming indirect spending in retail
Exhibit 3 of 3

Exhibit 3 Retailers can use a range of tactics to change mind-sets and behaviors.

The influence model’s four building blocks of change

UNDE
RST
AN
I NG DI
L NG
DE
O

AN
M

D
LE

 Cross-functional  Case for change

CO
RO

steering committee  Intelligent target

NV
 Senior sponsorship setting
of initiatives

ICT I
 External visibility
 Early wins  Test and learn

ON
 Program leader  Personal targets
and team  Weekly program-
 Initiative resourcing management rhythm
Category experts Implementation-

S
 

SM
TA

 Training level tracking

L

NI
EN

HA
T

N
C
A

D E
SK M
ILL M AL
S OR
F

Reinforcing with formal mechanisms weekly program-management rhythm is much

Company goals should be translated into personal
targets. One retailer created a simple time line of
when initiatives were expected to deliver impact, using
the top end of the impact range estimated for each
initiative. The resulting quarterly figures became
targets for the relevant executives, whose bonuses
were partly dependent on hitting those targets.
To follow up on progress against targets, many
retailers instinctively go for a monthly cadence
of follow-up meetings. But, in our experience, a
more effective for driving the pace of initiatives and
bringing about cultural change. During the weekly
meeting, the team reviews all initiatives but focuses
on only a few, either on a rotating basis or to help
those that need additional support.
Initiatives should be tracked not only against
milestones but also on progression through
“implementation levels”: an initiative begins as
an idea, matures to a business case, becomes
an approved decision, gets implemented, and is

Beyond procurement: Transforming indirect spending in retail 7

 ultimately converted to “money in the bank.” The
expected impact of initiatives can be appropriately
“discounted” when they are in earlier stages.
Implementation-level tracking gives the program
leader and steering committee a more accurate
picture of when impact will be delivered and which
initiatives need what kind of support. Linking this
tracking to ongoing budgeting, forecasting, and
performance-management processes yields greater
transparency in profit-and-loss performance.
Developing talent and skills
An NFR program needs a capable program leader
and a supporting team. The program leader,
who will likely come from a line role, should know
the business well and have the respect of top
management. Given this individual’s talent and
leadership skills, it won’t be an easy decision for
senior executives to free him or her up to lead the
program. But the sacrifice will pay off.
Still, without sufficient resources for each
initiative, the program will struggle. Colleagues
from each function or cost category will need to
dedicate 10 to 20 percent of their time to the effort.
For one $10 billion retailer, delivering $200 million
in savings required a program leader and about
40 full-time equivalents (FTEs) working for
12 months. Company leadership had to stop or
pause other initiatives to create the required
capacity. While 40 FTEs might sound like an
enormous investment, the retailer recouped the
cost of those employees’ yearlong efforts about
50 times over in recurring savings.
Neither the program leader nor the team members
can be expected to have all the relevant category-
specific expertise. Our research shows that
retailers have eight times the indirect spend per
procurement professional compared to other
sectors, which means their level of expertise in
any particular category will be relatively shallow.
Therefore, tapping into internal and external
8 Beyond procurement: Transforming indirect spending in retail
category experts is crucial. One grocery retailer
discovered that one of its project managers had been
a refrigeration engineer for 25 years. The company
brought him into a team tasked with reducing
the life-cycle cost of refrigeration, heating, and
cooling assets by 30 percent in two years. The team
achieved the goal in six months and did so with
simple solutions—for example, changing the type
of price tags used in refrigerated shelves so that the
tags wouldn’t fall off and clog the drain. This change
saved the retailer more than $600,000 a year.
Capability building is also key. The best companies
use a combination of classroom training, e-learning
tools, and on-the-job coaching. In our experience,
many NFR professionals who receive functional
and category-specific training and mentoring
immediately double or triple their effectiveness. A
phased train-the-trainer approach—in which the
sourcing team receives training during a pilot phase,
applies the learnings to an initial set of categories,
then trains others in the next phase—has proven
effective in many cases.
Role modeling
The CEO, CFO, and the rest of the management team
must work together to communicate the case for
change and role model the desired mind-sets and
behaviors. Working as a cross-functional steering
committee, they can remove roadblocks, surface
and capture cross-functional opportunities, and
allocate enough resources to them, thereby sending
an unmistakable message to the organization about
the importance of these initiatives.
Another powerful role-modeling lever is senior
sponsorship of initiatives. Senior leaders can serve
as coaches for the owners of individual category
initiatives, whether those owners are within or
outside the senior leaders’ respective functions.
Helping to secure—and then celebrate—early wins
is also a form of role modeling. It lets the entire
organization see that senior leaders are committed
1
to ensuring the NFR program’s success and that they
recognize its impact.
2
Most retailers have significant opportunities
to reduce indirect costs. The first step is to
acknowledge that the potential exists, then conduct
a thorough diagnostic to quantify it. Though
challenging, a transformation in indirect spending
can yield greater profitability, funding for growth,
and competitive advantage.
Beyond procurement: Transforming indirect spending in retail
For more on digital solutions in procurement, see Pierre de la
Boulaye, Pieter Riedstra, and Peter Spiller, “Driving superior
value through digital procurement,” April 2017, McKinsey.com.
For more on the influence model, see Tessa Basford and Bill
Schaninger, “The four building blocks of change,” McKinsey
Quarterly, April 2016, McKinsey.com.
Steve Hoffman is a partner in McKinsey’s Chicago office,
and Patrik Silén is a partner in the London office.
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